Securities Lending and Information Acquisition Stefan Greppmair Stephan Jank Pedro Saffi Jason Sturgess Mannheim Deutsche Bundesbank Cambridge JBS Queen Mary Inquire UK - June 2020 Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 1 / 18
Introduction Motivation Informational Role of Prices ◮ How prices incorporate new information is a defining feature of markets ◮ Large literature on how informed investors acquire and trade it: Grossman & Stiglitz (80), Admati (85), Diamond & Verrecchia (87) Wang (93), Chen, Hong & Stein (01), Banerjee (11), Goldstein & Wang (15) ◮ Why do investors trade differently? Differences of opinion, investment opportunity sets, private information acquisition, how they process information, etc. ◮ Loads of research show that some investor types (or strategies) have superior ability In particular, short selling activity forecasts future returns. Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 2 / 18
Introduction Source: Boehmer et al. (10) Stocks Performance ranked by Short Interest Monthly returns on lightly shorted stocks Cumulative returns on lightly shorted stocks Monthly returns on heavily shorted stocks Cumulative returns on heavily shorted stocks Monthly Fama-French-Carhart alphas (abnormal returns) on bottom and top 1% SIR portfolios 4% 0.8% Cumulative Fama-French-Carhart alphas (in %) Monthly Fama-French-Carhart alphas (in %) 3% 2% 0.3% 1% 0% 1st month 2nd month 3rd month 4th month 5th month 6th month -1% -0.2% -2% -3% -0.7% -4% -5% -1.2% -6% Number of months after portfolio creation ◮ High SI stocks underperform and Low SI stocks outperform ◮ Long-short strategy alpha: Almost 18% per year Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 3 / 18
Introduction Securities Lending Securities Lending ◮ Huge growth of short selling activity 1609: First recorded short by Dutch trader Isaac Le Maire. Oct-2018: Short selling accounts for 42% of trading volume at the NYSE. ◮ SEC’s Definition: “The sale of a security that the seller does not own. In order to deliver the security to the purchaser, the short seller will borrow the security, typically from a broker-dealer or an institutional investor.” ◮ The market supporting short sales is known as the " securities lending market " Dec-2018: ISLA reports e 2.2 trillion in outstanding loans, with e 8.8 billion in fees. ◮ What are the options for a lender that observes an increase in shorting demand? Increase lending to earn higher fees? Recall shares and sell position completely? Partially? Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 4 / 18
benefjcial owner of types of fjrms lend the most assets particularly in certain fjxed income Introduction Securities Lending Exhibit 4 - Lendable assets by fund type Lendable Assets by Lender Type 7% 2% 7% 16% 1% Insurance Companies Banks/Broker Dealers Govt/Sovereign Entities/Central Banks Corporations, LLP, LLC and Foundation & Endowment Mutual/Retail Funds 19% Pension Plans Undisclosed/Other Source: IHS Markit, December 2018 48% ◮ Main lenders: Mutual funds (passive and active) and ETFs Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 5 / 18
Introduction How Do Short Sellers Deliver Alpha? How Do Short Sellers Deliver Alpha? ◮ Literature: Asquith et al. (05), Cohen et al. (07), Boehmer et al. (08), Diether et al. (08), Boehmer et al. (10), Engelberg et al. (12), Richardson et al. (19) ◮ Where does this skill come from? Private information uncovered by short sellers: Karpoff & Lou (12), Boehmer et al. (20) Better processing of public information: Engelberg et al. (12) Compensation for risk and liquidity provision: Diether et al. (09), Richardson et al. (19) ◮ Short selling is an important channel to reveal negative information Do equity lenders react faster to an increase in demand? Do equity lenders’ actions complement or supplement those by short sellers? Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 6 / 18
Hypotheses Main Hypotheses 1 After an increase in shorting demand, active funds that lend stocks decrease their holdings faster than passive funds. 2 After an increase in shorting demand, active funds that lend a stock react faster than active funds that do not. Hinges on private signals from sec lending being more informative than public short data. 3 Positions closed by active funds that lend have less negative returns before the exit than those held by non-lenders. After the exit, return are more negative. Securities lending make funds trade more aggressively and amplifies shocks Active funds that lend shares leave “losses on the table”. Consistent with strategic complementarities in trading (Goldstein & Yang (15)). 4 Securities lending allows active lenders to front-run public disclosures about large short sales positions. Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 7 / 18
Data Data Description Sample Construction ◮ German mutual funds’ holdings and securities lending data Monthly portfolio holdings reported to Bundesbank’s IFS from Dec-14 to Dec-18. Monthly security lending by funds at stock level. Focus on equity funds with $10m+ AUM with at least three years. ◮ Markit’s equity lending data Aggregate data on equity lending markets. On Loan ≈ 2.5% of market cap.; Fee around 84 bps p.a. ◮ Morningstar: German active and passive mutual funds’ returns and characteristics. ◮ Datastream: Stock data from 23 developed markets as in Fama-French (2012). ◮ Large Short Positions: Reg 236/2012 harmonises short selling regulation in the EU From Nov/2012, short positions above 0.5% of market cap must be reported. 128,968 large short disclosures involving 6,381 stocks across 28 member states. Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 8 / 18
Data Data Description Descriptive Stats: Tables 1 & 2 More Stats - Table 3 AUM (in billion e ) Investment Focus Number of Funds Global 87 2,712 Europe 135 1,934 Germany 57 2,328 Other 35 239 ALL 314 7,213 Fund-Level Lending Obs % Lending All Funds 314 33.12% Active Funds 262 25.57% Passive Funds 52 71.15% Stock Lending Obs Mean Median St. Dev. 25th Pct. 75th Pct. % of AUM Lent 2,551 3.40% 3.52% 0.90% 2.31% 4.70% % of Position MV Lent 21,645 55.44% 36.18% 17.71% 57.67% 92.75% Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 9 / 18
Results Estimation How do Funds React to Shorting? Y i , j , t = β 1 SecLend i , j , t − 1 × Active j × OnLoan i , t − 1 + β 2 SecLend i , j , t − 1 × OnLoan i , t − 1 + β 3 SecLend i , j , t − 1 × Active j + β 4 SecLend i , j , t − 1 + X ′ i , j , t − 1 γ 1 + X ′ i , j , t − 1 γ 2 × Active j + α i , t + α i , t × Active j + α j , t + α i , j + ǫ i , j , t ◮ Main dependent variables ( Y i , j , t ): % Position change for a given stock in a given fund relative to last month. % Position change but fund still owns the stock. D ( Exit ) = 1 if the fund has sold all shares held of a given firm, zero otherwise. ◮ Control variables: Lagged position change, portfolio weight, Amihud’s ILLIQ. Fixed effects at stock-time, fund-time, stock-fund, and stock-time-active levels. ◮ Key coefficient is the triple interaction: SecLend i , j , t − 1 × Active j × OnLoan i , t − 1 Tests if active lenders that lend react more to an increase in short sales demand. Lack of change by passive funds is also a nice placebo test. Pedro Saffi (Cambridge) Securities Lending and Information Acquisition Inquire UK Seminar 10 / 18
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